Answer

The 16th Finance Commission (FC) constituted under Article 280 plays a pivotal role in redefining fiscal federalism, balancing states’ autonomy with the need for accountable governance and national fiscal stability. It must ensure equitable distribution, efficient spending, and deepened local governance within limited fiscal space.

Balancing Devolution with Fiscal Stability

Ensuring Responsible Expenditure

• Curtailing revenue deficits: Many states borrow to fund day-to-day expenses, undermining fiscal health.
• Reforming cash transfer schemes: Expansion of politically-driven schemes raises fiscal pressure and may misallocate resources.
• Reducing non-merit subsidies: Unchecked spending on populist subsidies strains budgets and weakens infrastructure spending.
  Example: Untied transfers often fund non-merit subsidies like free power and water, instead of capital investment.

Addressing Regional Inequalities

• Differential fiscal capacity: States like Bihar need higher support to bridge gaps in public spending and services.
  Example: Bihar has much lower per capita spending compared to wealthier states, reflecting severe inter-state disparity.
• Tailored grants for weaker states: Equalization through need-based grants can support lagging states without hurting efficiency.
• Capping centralized schemes: Reducing dominance of CSS can allow flexibility for states to meet diverse regional needs.
  Example: Many Centrally Sponsored Schemes (CSS) overlap with state and concurrent list functions, limiting flexibility.

Strengthening Third-Tier Governance

• Higher local government allocation: Strengthening fiscal transfers to panchayats and municipalities ensures grassroots development.
  Example: India’s local governments receive less funding than counterparts in China and South Africa, undermining service delivery.
• Incentivizing devolution by states: Transfers to states should be linked to their progress in empowering local bodies.
• Tied grants for local reform: Funds can be conditional on improvements in planning, budgeting, and service delivery by local bodies.
  Example: Without reform-linked incentives, increased allocations risk being underutilized or mismanaged.

Challenges Faced by the 16th Finance Commission

• Shrinking divisible pool: Rising cesses and surcharges reduce the effective share for states.
  Example: Divisible pool fell from 88.6% of gross tax revenue in 2011–12 to 78.9% in 2021–22.
• States’ rising debt burden: Many states face revenue deficits, borrowing heavily for non-productive spending.
  Example: Borrowing increasingly funds interest payments and daily functioning instead of capital investments.
• Freebie culture: Political pressure drives expansion of cash transfer schemes, risking fiscal prudence.
• Delayed third-tier empowerment: States have not devolved sufficient powers and funds to local governments.
• Centre-state fiscal tensions: States demand up to 50% share in taxes, affecting Centre’s ability to meet core obligations.
  Example: Current 41% devolution is under stress as states seek higher shares amid shrinking actual transfers.

Way Forward

• Rework transfer design: Shift from tied CSS to untied, need-based transfers respecting state autonomy.
• Incentivize prudent spending: Link grants to reduction in revenue deficits and responsible budgeting.
• Cap non-merit subsidies: Encourage states to limit inefficient schemes like free power/water through conditional funding.
• Strengthen local governance: Provide funds tied to institutional reform and local capacity building.
  Example: Without incentivizing devolution, local bodies may continue underfunded and ineffective.
• Balance equity and efficiency: Structure transfers to ensure poorer states catch up while maintaining fiscal discipline.
  Example: Untied transfers alone may widen disparities in public service delivery without addressing low-capacity governance.

The 16th Finance Commission must balance states’ demand for greater devolution with the imperatives of fiscal discipline, regional equity, and local empowerment. A strategic mix of performance-based grants, restructured schemes, and cooperative federalism is key to building a fiscally resilient India

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